The Rise and Rise of Dividend Stocks?
The Rise and Rise of Dividend Stocks?
Dividend growth stocks may get a relative boost if central banks cut interest rates to a lesser degree than expected in 2025.
For many investors, dividend-paying equities have taken a back seat in recent years to the high-flying growth potential of various secular theme stocks that generally don’t pay dividends. But if history is any guide, investors should not forget about dividend payers. In fact, the long-term case for them is compelling: a dollar invested in the S&P 500 Index in 1927 without dividends reinvested would be worth $243 today, but the same dollar with dividends reinvested would be worth $3,737.
Thankfully, one may not need a hundred-year investment window to reap the potential upside in dividend stocks, and the nearer-term outlook seems to be improving. Already, in the second half of 2024, the global monetary easing cycle has generally led to lower bond yields, rendering fixed income less competitive to dividend payers. As well, the highest dividend paying companies in the market typically carry more leverage; declining bond yields help them better manage interest expense, supporting overall financial performance.
Looking ahead to next year, there is legitimate concern that rates might not come down as much as investors previously anticipated, particularly in the U.S. But central banks are still very likely to make at least some cuts, which could still be positive for dividend payers. At a minimum, the rate environment heading into 2025 is undoubtedly an improvement over the past few years.
There also may be an upside to rates not coming down as much as expected. If they don’t, that likely means the economy is performing better than anticipated, which means we may have managed through an economic cycle without a significant slowdown or recession. If that happens, many of the more cyclical dividend payers could become even more attractive due to their business models potentially benefiting from any resurgence in global growth. These cyclical dividend payers are generally in sectors like Financials, Energy, selective Industrials, Consumer Discretionary and real estate investment trusts (REITs). Defensive dividend payers, by contrast, are in telecommunications, utilities and pipelines, for example. Importantly, the Canadian market has plenty of both cyclical and defensive dividend stocks.
If the prospect of a “no landing” or a “soft landing” for the economies, in both Canada and the U.S., becomes a reality and we do not get as many cuts as expected, the environment could become ripe for dividend growth, rather than dividend yield, as an investing theme. Companies that are increasing their dividends generally can do so because of the health of their business models, balance sheets and future earnings potential. These characteristics are obviously desirable, and the historical data shows that they are also rewarded by market participants. Dividend growers tend to outperform the rest of the market, with lower volatility.
S&P 500 Index Annualized Returns for Different Types of Dividend Payers (January 1990 – August 2024)
Source: Strategas as of August 31, 2024. Based on S&P 500 Index constituents. Dividend cutters are companies that cut their dividend in any calendar year during the time frame noted. Dividend growers are companies that increased their dividend in any calendar year during the time frame noted. One cannot invest in an index. Past performance is not indicative of future results.
Given this improving climate, it’s no surprise that more and more companies are initiating dividends. Just a few years ago, it would be unthinkable that big tech companies would become dividend payers. But today the prospect pool for dividend stocks is clearly growing, and it is meeting an immense amount of capital that has been hedging interest rate risk by sitting in money market instruments. With short rates coming down, that capital will need to find a new home, and some will almost certainly flow into strong dividend-paying areas of the market. If it occurs, that trend would bode well for dividend stocks – and the investors who see their potential while others are focused on more trendy names.
As Vice-President and Portfolio Manager, Stephen Duench is a key contributor to AGF’s quantitative investment platform. AGF’s Quantitative Investing team is grounded in the belief that investment outcomes can be improved by assessing and targeting the factors that drive market returns. Stephen is the lead Portfolio Manager of the AGF Canadian Dividend Income Fund and AGF North American Dividend Income Fund and is central to the creation and support of AGF’s portfolio management tools, analysis and applications across both Canadian and global mandates.
He began his career with AGF as part of the Highstreet† Investment Management team, involved in the management of both public equity and fixed income institutional and high-net worth portfolios. Stephen now serves as co-head of Highstreet Private Client, leading the firm’s strategy around investment management and allocation across multiple asset classes.
Stephen earned an Honours degree in Financial Mathematics from Wilfrid Laurier University and is a CFA® charterholder.
The views expressed are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds, or investment strategies.
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